What is an interest rate differential penalty on a fixed mortgage in Ontario?

The interest rate differential (IRD) is the prepayment penalty most commonly applied when you break a fixed-rate mortgage before the end of its term. Unlike the variable-rate three-month penalty, the IRD can be substantially larger and far less predictable.

The IRD is calculated by comparing your current mortgage rate with the rate the lender could charge today for a mortgage matching your remaining term, then multiplying that rate difference by your outstanding balance and the remaining months in your term. If you locked in at a high rate and current rates are much lower, the IRD can be very large because the lender is compensating for the profitable loan it is losing.

Lenders use different posted rates versus discounted rates in their IRD calculations, which can dramatically affect the penalty. Some lenders are known for IRD calculations that produce much higher penalties than others for the same mortgage balance and rate gap. The Financial Consumer Agency of Canada has noted that posted-rate-based IRD calculations can be aggressive. Before breaking a fixed mortgage, get the exact penalty in writing, ask how it was calculated, and have your mortgage broker or lawyer review the methodology. Sometimes it is cheaper to wait until the end of the term or to restructure the loan differently.